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Investment Overview for McDonald's (NYSE:MCD)
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Below are key drivers of McDonald's value that present opportunities for upside or downside to the current Trefis price estimate:
Franchisee Rent & Fees
- Average Spend per Customer Visit at McDonald's Franchised Restaurant: Historically, the Average Spend per Customer (ASC) has increased at a rate of 3-4% per year. In 2011, it was $3.37 and going forward we expect it to increase to $3.82 by end of 2019. However, McDonald's has been pushing hard to improve its brand image by refurbishing restaurants and introducing free Wi-Fi. The company is also extending its McCafe brand (which report higher revenues on an average) to more and more restaurants. Should the ASC increase to $4.5 by the end of 2019, we could see a 15% upside to the Trefis price estimates. At the same time, McDonald's is opening new outlets mostly in developing countries, which usually witness a lower ASC, primarily due to purchasing power disparity. There could be a 10% downside if the ASC falls to rise from the current levels.
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McDonald's owns and franchises its restaurants all over the world. By the end of 2011, the company had 33,510 restaurants in 119 countries, of which 27,075 were operated by franchisees and 6,435 were operated by the company.
McDonald’s essentially offers a uniform menu, though with minor variations to suit the local taste. A typical McDonald’s menu includes burgers, sandwiches, salads, snacks, breakfast sandwiches (McMuffins), beverages (soft drinks, coffee, milk shakes, juices), and desserts (ice cream, pies, smoothies).
McDonald's competes primarily with Wendy's and Burger King in the hamburger fast food category and has nearly 90% of the market share.
In the overall fast food industry, McDonald's is the market leader with a 19% share followed by Doctor's Associates and Yum! Brands.
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We believe that Franchisee Rent & Fees is more valuable than Franchisee Royalties and Company Operated divisions due to the following reasons:
Rent & fees income is two times more than franchisee royalties income
Both the Franchisee Rent & Fees and Franchisee Royalties divisions represent the two different channels of revenue contribution from McDonald's franchised restaurants. McDonald's operates three kind of franchised restaurants (conventional, developmental & affiliated) and charges them royalty, rental and initial setup fees. While royalty is charged to all franchised restaurants, rental and initial set up fees are paid by only conventional franchises.
Rent & fees charged as a percentage of sales is approximately two times greater than the royalty percentage charged to franchisees. This makes the Franchisee Rent & Fees division nearly twice the value of the Franchisee Royalties division.
Franchises profit margin is 4x that of company operated restaurants
Company-operated restaurants are low margin businesses (~20% operating margin) as compared to franchised restaurants (~80% operating margin). The difference in margins is mainly because of the extra costs involved with company-operated restaurants, such as employees and operational costs, which are absent for franchised restaurants. This is the primary reason why McDonald's and other chains prefer the franchise model despite lower revenues.
Number of franchised stores is nearly four times the number of company operated restaurants
Compared to 6,435 restaurants self operated by McDonald's, 27,075 restaurants were operated by franchisees globally. Going forward, we expect the company operated stores to decline further as McDonald's re-franchises them.
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McCafe gives McDonald's a strong presence in the specialty coffee segment
McCafe represents McDonald's foray into the high-margin caffeinated beverages market dominated by premium coffee chain Starbucks. In 2011, McDonald's expanded the brand to another 500 outlets in Canada. McDonald's has been able to keep the prices competitive and margins healthy due to its excellent store network, its marketing muscle and a highly efficient supply chain. McCafe's menu has been extended to more than coffee and now includes fruit smoothies, mocha and chocolate shakes.
Competition between McDonald's and Starbucks to intensify with McDonald's Frappe and Starbucks' Seattle's Best Coffee
On an average, McCafe outlets generate 15% more revenues than the regular McDonald's. McDonald's ensures new items are added to the menu regularly. As a result of the success of McCafe, Starbucks is reviving its Seattle's Best Coffee brand to compete with McDonald's. Starbucks has partnered with Burger King and Subway (both these chains compete with McDonald's), AMC movie theaters, supermarkets and coffee houses across the US to sell its coffee. This partnership will provide Starbucks access to more than 30,000 new locations.
Trefis Forecast Rationale for Capex as % of Revenues
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Capital Expenditures are cash expenditures by the company to purchase, repair, or upgrade physical assets, such as property, buildings or equipment. We forecast company wide Capital Expenditures using ${forecast} and allocate a proportion to each division.
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The ${forecast} increased from 9.1% in 2008 to 10.1% in 2011. In 2011, McDonald's spent a whopping $2.6 billion on capital expenditure mainly to open new restaurants and refurbish the existing restaurants.
In 2012, the figure grew to 11.1%. Going forward, we expect the ${forecast} to stay in a similar range.
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Trefis considered the following forecast for its forecast
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- McDonald's to open new restaurants and refurbish the existing ones
- McDonald's plans to open 1300 new restaurants in 2012 with a greater focus on China, India and East Europe. Although the franchised restaurants take minimal expenditure to open, the entire cost of opening a company-operated restaurant is incurred by McDonald's. With the majority of the restaurants in China being company-operated, capital expenditures are going to remain high for 2012 and beyond.
- McDonald's is trying hard to revamp its image of a large-scale burger producing company by refurbishing its existing restaurants and introducing more comfortable seating in order to appeal to a wider range of people. The company is also offering free Wi-Fi in a greater proportion of restaurants to compete directly against Starbucks. In 2012, the company plans to refurbish 2400 existing restaurants in the U.S.
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- Rate of expansion will slow down
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McDonald's plans to open 1300 new restaurants in 2012, a number which is significantly higher than its historic average. Expanding at this pace is not feasible in the coming years. Thus, capital expenditures as a percentage of revenues will witness a decline.
Back to Company OverviewHow Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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